Business divorce cases are most often litigated in state courts, and that can create difficulty for all those involved. Based on anecdotal evidence (me talking with members of the judiciary at various lawyer events), many Pennsylvania judges see only a few business-flavored cases a year and it could be several years between when they see a significant business divorce. Dockets are crowded and the businesses at the hearts of these cases tend to suffer as time passes. Many county courts use case management systems that result in different judges hearing different parts of the case, which creates a mess in a complex owner dispute.

For those reasons, we always take a hard look at whether we can get a case into federal court. Here are some things that have worked over the years and some that haven’t.

A Primer on Federal Court Jurisdiction in Business Divorce Cases

Recall that the two most common forms of federal subject matter jurisdiction are diversity of citizenship (28 U.S.C. § 1332) and federal question (28 U.S.C. § 1331). Section 1332 vests federal court with jurisdiction over disputes where the parties are citizens of different states and the amount in controversy is over $75,000. There must also be “complete diversity” among the parties, meaning no plaintiff may share citizenship with any defendant.

The requirement of complete diversity is often difficult to meet in business divorce cases because of the prevalence of limited liability companies, particularly for small and mid-sized businesses. Corporations are citizens of their state of incorporation and the state where they have their principal place of business. Limited liability companies, however, are treated very differently. An LLC is a citizen of every state where any of its members is domiciled.

Diversity is often impossible to achieve when the company at the center of the dispute is a limited liability company because the company, a citizen of every state where one of its owners is domiciled, is often a party to the case. For example, when a minority member is suing the company and the majority member for an alleged wrong or where the company is suing a minority member, the member and the LLC (by virtue of the member’s domicile) will be domiciled in the same state defeating diversity. Here’s a nice article from the ABA taking a little deeper dive: (https://www.americanbar.org/groups/business_law/resources/business-law-today/2019-august/diversity-jurisdiction-involving-an-llc-member/).

That leaves us with federal question jurisdiction. Section 1331 vests federal court with jurisdiction over disputes involving federal law, for our purposes, federal statutes. The rub, of course, is that the bread-and-butter claims in business divorce cases all arise under state law – shareholder oppression, breach of fiduciary duty and breach of contract – and don’t offer a ticket to federal court.

Fear not – I will share with you my meandering experience in looking for and litigating federal questions in business divorce cases.

Federal Claims That Tend to Work Well in Business Divorce Cases

Defend Trade Secrets Act (DTSA)

The Defend Trade Secrets Act of 2016 is a reliable federal hook in a business divorce case. The statute is relatively straightforward and requires plaintiff to show “(1) the existence of a trade secret, defined generally as information with independent economic value, which the owner has taken reasonable measures to keep secret; (2) that is related to a product or service used in, or intended for use in, interstate or foreign commerce; and (3) the misappropriation of that trade secret.” Oakwood Laboratories LLC v. Thanoo, 999 F.3d 892, 905 (3d Cir. 2021).

It seems like almost every time a relationship between an owner-employee and a company sours, there’s some allegation of trade secret theft. An owner leaves and tries to start a competing business with the help of the company’s customer data. They believe they’re entitled to take company technology because they developed it (on company time). Or sometimes they just want to cause trouble by passing information to a competitor.  The point is that this kind of bad behavior is often enough to act as a ticket to federal court.

Lanham Act

The Lanham Act is the stock and trade of intellectual property lawyers, but its application is far broader than the uninitiated might expect. It establishes the registry system for trademarks and protects against infringement, yes, but its broad prohibitions on unfair competition contained in 15 U.S.C. § 1125(a) and its “anticybersquatting” provisions contained in 15 U.S.C. § 1125(d) can have application to common business divorce fact patterns. (This topic merits its own article, but let’s scratch the surface here). 15 U.S.C. §§ 1125(a)(1)(A)-(B) prohibit false association and false advertising.

In the 3rd Circuit, false association claims require four elements: “(1) the defendant used a false designation of origin; (2) the use occurred in interstate commerce; (3) the alleged false designation is likely to cause confusion, mistake, or deception regarding the origin, sponsorship, or approval of defendant’s goods or services by another; and (4) plaintiff is or is likely to be damaged as a result” I.M. Wilson, Inc. v. Otvetstvennostyou “Grichko,” 500 F.Supp.3d 380, 413 (E.D. Pa. 2020).False advertising claims require plaintiffs to prove five elements: “(1) the defendant made a false or misleading statement of fact about the plaintiff’s product or service, (2) the statement actually deceived or tended to deceive a substantial portion of the message’s intended audience, (3) the statement likely influenced the intended audience’s purchasing decisions, (4) the defendant introduced the statement in interstate commerce, and (5) a causal connection between the defendant’s statement and the plaintiff’s injury” Parks, LLC v. Tyson Foods, Inc., 863 F.3d 220, 227 (3d Cir. 2017). Neither requires proof of common law fraud, scienter or actual reliance. The Lanham Act’s anti-cybersquatting provisions (15 U.S.C. §§ 1125(d)) prohibit the use of confusing URLs or other Internet designators.

One common business divorce fact pattern we see is when a disgruntled owner begins usurping business opportunities for their own account. We’ve had circumstances where disgruntled owners have created business names, logos, or other branding pieces that look confusingly similar to that of their company. Sometimes they use more subtle techniques, for example, by making outreach to potential business opportunities using their company email that contains the branding of their company in the URL or the footer. In doing so they create confusion in the eyes of the customer that it is the company providing the goods or services rather than the disgruntled shareholder or the competing company doing so. This type of behavior can get you into federal court.

Computer Fraud and Abuse Act (CFAA)

The CFAA is another perennial favorite to get into federal court and can be deployed against disgruntled owners that access company computer systems without authorization. Pleading a claim under the CFAA is a bit of a headache and requires plaintiff to meet a variety of technical requirements, including, in particular, a $5,000 loss that arises from responding to unauthorized access to a system. Notwithstanding, a disgruntled owner improperly taking or deleting company information from company systems after termination of their employment is a common business divorce fact pattern.

A Federal Claim That Tends Not to Work Well

Civil RICO

Civil RICO sounds awesome. Who doesn’t like treble damages and attorney’s fees? But the juice is not usually worth the squeeze in business divorce cases. See my prior article here: https://www.pabusinessdivorceblog.com/2021/05/civil-rico-in-pennsylvania-business-divorce-cases-a-hammer-without-a-nail/.

Parting Thoughts

Federal court is not the natural home for most business divorce disputes, but that does not mean it is out of reach. When diversity jurisdiction is unavailable – as it so often is in these cases – the question becomes whether a legitimate federal issue exists that reflects the real-world misconduct already at play between feuding owners. In the right circumstances, the Defend Trade Secrets Act, the Lanham Act, and the Computer Fraud and Abuse Act can provide a viable and defensible path into federal court. Don’t waste time on Civil RICO.

The key is discipline and realism. Federal courts are quick to spot—and dispose of—claims designed solely to manufacture jurisdiction.